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On the rise

With Japan more open to foreign investment than ever before, M&A practitioners hope to take advantage.

Japan is rapidly shedding its reputation as a country and economy closed off to foreign investment—and M&A dealmakers have been at the forefront of the inbound transaction resurgence.

Years ago, it would have been unthinkable for a foreign investor to buy a Japanese electronics giant or a deposit-taking retail bank....It now feels like anything is possible.

Figures from Thomson One Banker show that in 2015, there were 162 inbound Japanese deals worth US$25.4 billion, representing the highest annual inbound deal value in Japan for a decade and more than a fifth of the US$109.6 billion of total inbound deal value over the same period.

Inbound activity still trails outbound Japanese M&A by some margin (there were 465 outbound Japanese deals worth US$67.7 billion in 2015, according to the same data), but the outlook for rising inbound activity is bright.

"There has been plenty of outbound Japanese M&A and all the mood music has focused on the outbound story, but although inbound M&A is not at the same level, the growth in activity has been striking," says Dr. Ralf Bebenroth, professor of international business at Kobe University in Japan. "Before the 90s, there weren't even 50 inbound deals a year. If you fast forward to 2015, the picture has changed completely."

Interest in Japan from international investors is picking up, adds Jun Usami, a partner at White & Case in Tokyo. "Japan has much to offer. Its traditional industrial base is very strong, it has a highly skilled and well-educated workforce and its technology is advanced and sophisticated," he says.

Tosh Kojima, managing director and head of the Asia desk at corporate financier DC Advisory, says landmark transactions such as Taiwanese technology conglomerate Hong Hai's ¥388 billion (US$3.5 billion) acquisition of iconic Japanese electronics group Sharp earlier this year and CTBC's ¥53 billion (US$435 million) purchase of Tokyo Star Bank in 2014—one of the largest foreign takeovers of a Japanese lender ever—have opened the way for other overseas M&A investors.

"Ten years ago, it would have been unthinkable for a foreign investor to buy a Japanese electronics giant or a deposit-taking retail bank. These deals would never have been done," says Kojima. "That has all changed. It now feels like anything is possible."

Direction from the top

At the heart of the positive outlook for inbound M&A into Japan is a raft of measures introduced by Prime Minister Shinzō Abe to make Japan's economy more open and dynamic.

162
Inbound Japanese deals in 2015, worth US$25.4 billion.

Although Japan has a reputation for technological and industrial excellence, a focus on self-reliance and the domestic Japanese market has caught up with the country. According to the latest available figures from the Organisation for Economic Co-operation and Development (OECD), Japan's stock of inward foreign direct investment (FDI) in 2014 sat at just 3.7 percent of GDP, the lowest in the G7 by more than 10 percent and lagging the OECD average of 33.6 percent. Its economy has been equally anemic, contracting at an annualized rate of 1.4 percent in the fourth quarter of 2015. Japan's 2015 census showed that the country's population shrank by nearly 1 million people in the previous five years.

Prime Minister Abe has identified foreign investment as a key pillar to arresting the decline and reviving the economy, and introduced a series of measures to spark interest from overseas investors. Japan's corporation tax has been cut from more than 32 percent to less than 30 percent, visa rules have been relaxed to encourage highly skilled immigrants and their families to work and live in the country and new corporate governance rules introducing Western-style independent directors to the boards of Japanese corporates have also been put in place.

Japan's premier has also set a target for the Ministry of Foreign Affairs, the Japan External Trade Organization and the Council for Promotion of Foreign Direct Investment to double inward FDI stocks to ¥35 trillion by 2020 from ¥17.8 trillion at the end of 2012.

Other steps that have been taken are a series of measures to deregulate various industries including agriculture, medicine and energy, so that foreign companies may expedite the process of starting a business in Japan.

An example of such deregulation is the fast tracking of regulatory approval of medicine from overseas that have already received US Food and Drug Administration approval. As for accessibility to Japan's laws and regulations, official translations of more than 500 major Japanese laws and regulations are now available to foreign investors.

Furthermore, the living environment for foreigners in Japan has improved through government initiatives to ensure hospitals, banks, electric and gas companies offer their services in foreign languages. The Japanese government actively supports education for foreign children and encourages foreign students to stay and work in Japan through internship programs and job fairs. The English proficiency of Japan's younger generation has also strengthened since the government introduced English language programs that begin from elementary school.

"The general perception in Japan now is that the economy will not survive unless industry and business in the country is made more attractive for foreign investment. If Japan wants to continue competing globally, then it needs to open up to global investors," says Usami.

"Japanese companies have recognized that they can no longer afford to remain inward-looking," adds Bebenroth. "The pressure is building on Japanese corporates to remain globally competitive and in order to do that, they need to internationalize. If you look at the technology industry, for example, Japan produces excellent technology but has often been caught by surprise when it finds that it is behind other countries or moving in a different direction."

Kojima says generational and cultural changes have also helped to open up the country. "There is an acceptance that retrenching and defending an aging market by merging with other similarly challenged local companies is not the way to go," Kojima says. "There are many more mid-cap companies in Japan now, led by a generation of younger executives who have a different outlook to their parents. They have gone on backpacking holidays around the world and they have studied abroad. Working with overseas investors just isn't an issue for them. They have also watched the way their parents worked and observed that the promise of a job for life is not always fulfilled."

Challenges to overcome

While progress has been made to make Japanese business more cosmopolitan, challenges still remain.

"The inbound M&A figures are climbing but it is important to look behind the numbers," says Bebenroth. "Much of the inbound activity has been driven either by financial buyers or by the Japanese subsidiaries of multinational companies. Often the targets are the weaker divisions of Japanese corporates. The numbers are pointing in the right direction but there is still a long way to go. The next step is for international companies to start making large strategic investments in the country."

An activist investor or hostile takeover remains taboo and is hardly possible in Japan.

"It has long been the case in Japan that unless a company was in obvious financial or succession trouble, there would never be a classic M&A process," says Kojima.

30%
Japan's corporation tax has been cut to less than 30 percent to help revive the economy and spark interest from overseas investors.

Despite reforms to corporate governance rules, large company boards are still dominated and run by company men.

"When independent directors are appointed, they will inevitably still come from the same networks and business culture, where it is still not accepted to speak your mind and challenge the board's thinking," says Bebenroth. "Finding outsiders who also have a knowledge of the industry is very difficult. Japan is still a long way off from implementing a Western governance system with effective independent directors."

Foreign investors also need to adapt to the unique approach that Japanese companies take to running their businesses. In Japan, businesses are seen as being owned by society rather than just shareholders. Executives see themselves as institutional custodians and value customer service and employee relations higher than creating shareholder value. Western investors with ambitions of imposing their business philosophies on Japanese targets will make little progress.

A positive outlook

Despite all these challenges, however, Japan is changing, and overseas investors are getting better at understanding its nuances and opportunities. Japanese shareholders and employees are also recognizing the benefits that overseas investment can yield. Bebenroth, for example, has conducted a piece of research into the takeover of a Japanese company by a German buyer, examining how staff react to overseas ownership. Between 2012 and 2015, he conducted four rounds of questionnaires with additional interviews, asking employees at the target company how satisfied they were following the deal and what they felt about it. After each round, the clear finding was that staff felt happy about the foreign takeover.

"There was pride that their company had attracted investment from overseas and that they were now operating on a global stage. There are positive aspects to globalization and strategic deals from foreign investors are well received," says Bebenroth.

Kojima adds that deals such as Renault's investment in Nissan, which involved a carefully planned and successful cultural integration program, and Nokia's purchase of part of Panasonic's wireless business and 3G base station, which has also been well received by staff and facilitated the development of international systems and procedures at the asset, show that foreign takeovers have huge potential and and can work without compromising the core values and strengths of Japanese business.

For Usami, the direction of travel is clear and Japan is ready to take its place as a truly global player. "The Japanese government is proactively trying to attract as much foreign investment as possible and is restructuring the investment and social infrastructure to make the economy and country more open to international investors and companies."

He adds: "The yen is weak and the economy has recovered from the credit crunch. There has never been a better time to invest in Japan."

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